How does inflation lead to a devaluation

Exchange rates

flexible exchange rates:

  • depend on supply and demand on the stock exchange
  • Advantage: the rate reflects the real exchange relationships between two countries; The central bank does not have to concentrate on interventions, but can use its instruments to ensure domestic economic stability
  • Disadvantage: possible changes in course between the conclusion of a purchase contract and its payment; Governments shy away from restrictive measures for fear of being made responsible for unemployment, which increases inflationary tendencies and the risk of strong exchange rate fluctuations

fixed exchange rates:

  • are determined by states or their central banks
  • Advantage: Economy has reliable data for calculation in international trade
  • Disadvantage: Economy cannot adapt to different developments; there is currency speculation and a black market for foreign exchange

Changes in exchange rates:

  • Appreciation: External value increases, exchange rate decreases, consequences: export decline (our products become more expensive for foreigners), import increase (foreign products become cheaper for us), tourism increase (foreign currency is cheaper), jobs are endangered, price fall (inflation is slowed down), capital export increases to (investments abroad become cheaper); Problem: The export industry and workers are against it
  • Devaluation: External value decreases, exchange rate increases, consequences: increase in exports (our products are cheaper for foreigners), decrease in imports (foreign products are more expensive for us), decrease in tourism (foreign currency is more expensive), capital imports increase (foreigners are more likely to invest with us), jobs increase , Prices are increasing; Problem: if few exports are due to a poor supply of goods, devaluation does not bring relief, but makes the domestic economic situation more difficult due to higher import prices


  • Devaluation of a currency (monetary value decreases, the amount of money grows faster than the amount of goods, more is exported)
  • Causes: Economic boom leads to increased demand from private households due to increased incomes, companies ask for capital goods to expand capacity abroad because they are not available domestically, the state can spend more through more tax revenue, cost increases' all lead to price increases
  • low inflation is good for the economy
  • high inflation leads to capital misdirection (strong demand for real assets leads to a boom in real estate markets, if the inflation rate falls, nobody wants the construction properties), undesired redistribution of income and capital (savers lose assets, debtors gain interest) and a loss of confidence
  • Ways to curb inflation: reduce government spending, policy of high interest rates to curb borrowing, lower consumer demand, increase competition

Deflation: Appreciation of a currency (the value of money increases, the amount of goods grows faster than the amount of money, less is exported)

External value: the amount of foreign currency that is obtained for one unit of domestic currency. Increases with an appreciation, decreases with a devaluation.

Parity: Equilibrium, equivalence, comparative value of the currency units of two countries

Bandwidth: Area between the upper and lower intervention points

upper intervention point: upper limit of bandwidth. When the upper intervention point is reached, the respective central bank intervenes with support sales (sale of foreign currency in order to counteract foreign exchange shortages and to let the exchange rate fall), it intervenes.

lower intervention point: lower limit of bandwidth. When the lower intervention point is reached, the central bank intervenes with support purchases (purchase of foreign currency to counteract an excess of foreign currency and to let the exchange rate rise), it intervenes.

Ask rate: Offer or sell price

Bid rate: Demand or buying rate

Currency: Payment instructions in a foreign currency, i.e. checks, bills of exchange and telegraphic instructions for payment, are common in international trade

Sorts: foreign banknotes and coins, common in travel

Export: leads to supply of foreign currency

Import: leads to demand for foreign currency

Floating: free exchange rate that is formed without any intervention

dirty floating: Space between fixed and flexible exchange rates